Tuesday, March 24, 2009

Gold - Has The Bubble Built? Will It Burst Soon?

The world over, air has whooshed out of bubbles in stocks, crude oil, metals and real estate. But before recovery comes, another bubble needs to burst: the bubble in gold prices. Around $950 per ounce, gold is still close to its all-time high of March last year, when it closed at $1,002 per ounce, three times costlier than what it had been from 1999 to 2002.A gold crash sounds like heresy. Deep in our hearts is a belief that gold is the ultimate asset, the final port of call in times of instability, the safest thing to buy and hold when all else looks doomed. But the heart is an unreliable guide for these things. And the warning bells are ringing at home.

India is the world’s largest hoarder of gold. It’s reckoned that the stockpile of gold here now is more than the 8,000 tonnes stashed away in the US treasury’s vaults in Fort Knox. Unlike the US, where the government owns most of the gold, India’s government owns a measly 300-odd tonnes. The rest is in private hands: bridal jewellery in Godrej almirahs or bank lockers. And little of this hoard comes up for sale.

We take our women’s jewellery seriously. Selling your wife’s bridal baubles would be a last resort, a signal to society of moral and financial bankruptcy, deserving more social scorn than passing wind in a room full of prospective in-laws negotiating an arranged marriage. In Bengal, the tale that Rabindranath Tagore’s wife pawned her bridal gold to help her husband fund a university is the stuff of martyrdom even today.

But at today’s prices our greed for gold has evaporated. In February, India’s imports of gold were close to zero, down from 28 tonnes a year ago. In March, it’s the same story, no imports. Jewellery sales in the marriage season are expected to be low and a lot of bridal jewellery is mothers’ hoard, recycled. High prices have forced the world’s largest gold junkie to kick its habit.

Yet, reports hint that gold exchange traded funds (ETFs), pieces of paper whose value is linked to gold prices, are still pulling subscribers. Why are people buying paper gold when they can’t afford the real thing for their daughters’ marriages? Because speculators are buying the paper, when folks that really need gold can’t afford to. But who needs gold and why?

Historically, gold has been valued for adornment. Till about 500 years ago, it also had value as currency. But around the 16th century, paper currency started flooding the world, with good reason. Gold is very dense and heavy. A little cube of gold, measuring one foot on each side weighs half a tonne, about as much as a Maruti 800. Today this cube would be worth Rs 85 crore, but for that transaction nobody would lug a gold Maruti around. A weightless electronic money transfer would suffice.

In the 21st century, there are specialised uses of gold in tiny volumes for scientists working on fuel cells, or semiconductors, or heat resistant fabrics. Gold is inert, it doesn’t decay. A gold tooth filling made 5,000 years ago will fill your tooth today. It’s malleable, you can twist it to make any kind of shape, something jewellers have known for ages. These properties make gold interesting in the labs. But researchers in labs don’t set the price of gold. Who sets the price of gold is a story with a beginning and end.

After World War II, Europe and large parts of Asia were devastated. Factories, roads, railways and bridges had been blown to bits, most young men were dead or injured and economies were in free fall. Hyperinflation raged, making currencies worthless.

The way out was plotted when a group of wise men gathered in Bretton Woods, America, and worked out a plan to save the post-war world. The wisest of them, John Maynard Keynes, figured that to stop hyperinflation the world had to anchor all currencies to the strongest currency in the post-war world, the US dollar. And for good measure, anchor the dollar to gold, because America then had 75% of the world’s yellow metal.

So the price of gold was fixed and the only country that suffered no war damage on its soil, the world’s strongest economy, said that it would buy gold from anyone and pay 35 reliable US dollars for every ounce of gold. Then American aid poured into Germany and Asia. Those economies revived, currencies stabilised and, perhaps for the last time in its history, gold was the final arbiter of value.

That lasted 37 years. By 1968 the world was restive, America was bleeding in Vietnam and Europe had consolidated.Asia, especially Japan, was emerging as a manufacturing powerhouse. US inflation was soaring. A bunch of European speculators called ‘gold bugs’ bet that the US, plagued by poor growth, high deficits and rising inflation, would be forced to print money and snap the $35 per ounce anchor with gold.

The gold bugs were right. In 1971, president Richard Nixon pulled the plug on the gold standard. The dollar became a freely-traded currency and gold prices shot up to more than $40 per ounce in London. Through the 1970s and 1980s, the world was clobbered by two oil shocks that hiked crude oil prices by 15 times, high inflation and unemployment, and low growth. People turned to gold for value. The price of gold shot up from $40 to $850 per ounce, a return of about 30% every year.

But nothing is permanent. After 1980, normalcy returned and gold fell back to $250 per ounce and stayed there for nearly 20 years. From 2002, when all of today’s bubbles began, gold started climbing and now it’s right up there looking all pricey and out of reach. So when will it pop?

It took four months for the bubble in crude oil to burst spectacularly: from $147 a barrel in July to $40 in November 2008, a loss of more than 70%. We need oil to drive cars, heat homes, cook and power our airlines. But the yellow metal is intrinsically worthless. It shouldn’t take long for gold, a bauble competing with silver, platinum and other metals for jewellers’ attention to come off the highs.

About 150 years ago, John Ruskin wrote about a man who liked gold and turned all his wealth into it before sailing off. In high seas, a storm wrecked his ship. The man strapped his bag of gold around his waist and dived into the water and drowned immediately, dragged under by the weight of gold. Asked Ruskin: “Now as he was sinking, had he the gold? Or had the gold him?”Source: Economictimes

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